This is a concept that I have come crossed paths with time and again. It is also something we talked about in our article, Why growth is bad for your bank balance, which was published on December 5, 2019.
Amazingly, after that article, we went through COVID lockdowns, dangerously low interest rates, and an unnatural period of growth ensued.
Growth is a concept I learned about formally whilst at the bank, and it’s something I’ve experienced time and again, both personally and in business.
As we discussed in an earlier article, I’ve found that it tends to be readily misunderstood, or not thought through deeply enough, and I have seen many businesses (me included), make the mistake of not navigating it carefully. Growth is not all glitz and glam and it is something that can put a business under if not managed correctly. In fact, anecdotally, this was one of the biggest troublemakers I assisted with during my time as a banker and then later aiding businesses in navigating with their financial modelling.
I’m going to start at the end, a rule of thumb that I have always tried to follow and have always tried to advise people (clients, staff, myself…) is that growth costs. That’s it, that’s all, roll credits…
In all seriousness, it’s important to expand on the concept we noted down that Time + Money = Growth, and look at a few more examples, which is what we’ll do in this article. It is a topic that I will likely be revisiting in future as it is inevitable and will always cause problems, the key is to be mindful of it.
In the other article, we looked at the cost of growth, and it is a function of either spending more time or paying for the difference.
There are very few companies where this does not hold true, but even for those companies, it’s realistically a case that “costs” is not being defined properly.
So, noting that growth costs, let’s delve into this a little, shall we…
The first question to answer is, what is growth? How do we define growth?
What is it?
I think the common perception of growth is increasing revenue, but if you take a moment to look at our revenue drivers video, Breaking down revenue into drivers, the next question to ask is, what is driving that growth?
A general way to look at it is, any change that increases the activity of a business is considered growth. Growth can occur in two directions, vertical, horizontal or a combination of both, and here are some examples of how that might look:
- increase in sales of the same product / service (horizontal growth)
- introduction of a new product / service (vertical growth)
- taking that same product / service into a new market (horizontal growth)
- development to improve that same product / service (vertical growth)
- and I’m sure there are more examples, but those are common analogies and it is important to note that they do overlap
To help us define this, we’ll delve into a few businesses over a series of posts, and this one we’ll start with a professional services business, say an accounting practice.
What are the common pathways for starting an accounting business? Commonly, an accountant, “Jack” will start as a junior at a firm as a graduate, then they will slowly rise through the ranks learning more and more about the skillset of accounting. One day, they realise, “I can do this better myself”, or “I want to do this myself” and they decide to leave and start their own practice.
Getting to this point, Jack has learned skills either through education and/or work experience. The education would have come at a cost of time and money, and work experience costs time. The accountant might have broad formal training, but their experience is likely to be specific, namely specialising in specific skills like doing bookkeeping and accounting for clients, or they may gained certain experience like working with specific industries such as professional service businesses.
This means that the accountant will have built up relevant knowledge such as;
- How to set up accounting packages in a way that’s tailored to professional services businesses (appropriate chart of accounts, useful reporting packages, etc.)
- Have tax knowledge that relates to professional services businesses (tax rules, company structuring, etc.)
- Be able to provide some relevant advice on operational processes (how to invoice, what to put in an invoice, payables processes, etc.)
- Have an understanding of performance metrics that apply to these businesses and provide some guidance to owners. (Key profitability ratios, important rule of thumbs to understand business drivers, etc.)
Although Jack has experience and skills built up over his career, this is the first instance of growth for the business. This is an example of significant vertical growth where Jack has moved from being an employee to now running a sole practice.
In my experience, vertical growth tends to be when businesses can experience the greatest strain/stress. In this case, Jack’s first steps can be the most daunting as he will need to start learning new things, like fundamentals of running a practice, how to employ people, etc. This is where that growth equation comes into play. If Jack is confident, he can spend the time to set up systems, processes, documentation or he can pay someone to assist with some of this (time + money). As those are inversely related, the more money that gets spent, the less time required to reach their first growth milestone. Keeping in mind, you can’t negate the time in this equation, it is merely a case that the amount of time required reduces slightly.
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One pathway for Jack to take once the basics have been set up is to find more professional services clients and provide the same service to more clients. This would then be an example of horizontal growth. In growing horizontally at this point, the accountant would be able to provide the best possible service to clients (new and existing), which would maximise their potential to charge clients, as clients are more likely to feel like they are receiving the maximum value from Jack. Whilst this would seem like the right next step, what often happens is…
A lot of accountants don’t go down this pathway, let’s say Ryan, who has gone through a similar journey to Jack, but Ryan starts to find clients in all sorts of industries as finding clients is the most important thing, right? Yes, and no… Say the Ryan finds a client in the manufacturing industry, will this be an issue. Inherently no, if things are kept basic, maybe just do a tax return, or do the book keeping done. This might be sufficient as businesses at their core can be distilled down to some basic concepts (revenues and expenses). The issue arises if the client wants guidance outside of the core bookkeeping, accounting, or guidance around operational processes, or performance metrics, this may not be as readily available, or it could just be wrong.
In such this case, Ryan finds a variety of clients from various industries and is creating new verticals within his business. The proviso here is that taxes do tend to have some level of uniformity, so scaling vertically in this instance is more feasible than for other industries, so Ryan might be ok. The downside is that the Ryan will need to go along another learning curve each time a new industry participant signs up and isn’t necessarily making use of the years of education and experience that he’s already built. This is not necessarily bad but do keep in mind that this is growth and again it costs time and/or money.
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On the flip side, looking back at Jack who focuses on the core offering, and markets his bookkeeping & compliance services to professional services businesses. He is growing horizontally, and by focusing their marketing and sales efforts on finding clients in a similar industry, and even at a similar scale – this creates efficiencies of scale.
With horizontal growth, you’ll find that businesses will tend to either maintain gross profit %, or even improve gross profit % in spite of the revenue growth. This is generally due to incrementally less time and money being spent doing the same process or having that same process getting utilised more as revenue increases. Some examples might be:
- Implementing the same chart of accounts for professional services firms and charging for this.
○ Assuming a fixed fee is charged for this, ideally the process of doing this will generally improve over time either through templates or operator knowledge. - Providing structuring advice for the professional services firm, which will tend to be quite similar, or have very minor forks based on the profession.
○ Again, assuming a fixed fee is charged for the advice, the margin on this should improve over time with either templates or operator knowledge. - Focusing on the above, helps to move towards “productising” a service offering, and selling the value of the offering, rather than time.
- Another benefit of the above is structured offering also means training of new hires will also follow a more natural progression, and it also provides new hires a pathway to visualise the career trajectory.
Again, this is likely to come at a cost of time and money, but the money can be used more effectively by increasing cost at a slower rate to the increase in time, in order to reach the amount of growth.
Vertical growth can create issues, in the case of Ryan, he might start looking at manufacturing, he won’t have the benefit of having the above efficiencies and knowledge, but there might also be some areas where the compliance and/or tax advice is incorrect or incomplete. Ryan might realise this, but it’s time he’ll need to spend towards learning the knowledge gap. Early on this might be okay when Ryan isn’t too busy, but a compounding of having to learn new information as well as carrying out basic tasks can readily put a project over budget.
This is our first review of how growth may appear in one particular professional service-based business. We will examine another business model in the next article.
Until next time, thanks for reading.
Jun
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